Appeal court keeps parent company on the hook

The Court of Appeal has dismissed an appeal by Steel & Tube Holdings Limited (STH) against the legal basis and quantum of a $750,000 judgment based on a “de facto amalgamation” with its subsidiary company.

The ruling reinforces the message from the High Court that directors must be careful to maintain a subsidiary’s independence if they are to protect the parent against liability for the subsidiary’s debts.

The context

Stube, a subsidiary of STH, held a lease for land owned by Lewis Holdings Ltd. Stube was put into liquidation by a resolution of STH shareholders in 2013, at which stage the liquidators sought to disclaim the lease as onerous property.

Lewis took STH to the High Court which found that Stube was “devoid of any capacity to conduct its own affairs” and that Section 271(1)(a) of the Companies Act 1993 (the Act) applied.

This provision creates an exception to the principle that a company is a legal entity in its own right and that its shareholders are only liable for the company’s debts to the extent of their shareholding. It allows the Court to order the parent company of a company in liquidation to pay to the liquidators the whole or a part of all or any claims made against the subsidiary.

As the Court of Appeal observed, applying the provision requires the Court to balance two policy considerations:

“First, respect for the separate corporate identity of the company in liquidation. Second, avoiding the mischief that can result from an overly strict application of separate corporate identity.”

Chapman Tripp’s commentary on the High Court decision is available here.

The Court of Appeal

STH challenged the High Court’s ruling on a number of grounds, none of which was accepted by the Court of Appeal.

In particular it:

rejected the argument that STH had not caused any loss to Lewis by its conduct, saying: “The decisive factors here are the total extent to which Stube was absorbed into STH without consideration given to its separate corporate personality, and the ongoing representations by STH to Lewis that it stood behind and supported Stube”, and

dismissed STH’s submission that the High Court had been wrong to conclude that STH had disentitled itself through breaches of fiduciary duty by its directors on the Stube board. The Court of Appeal said that s 271 was not focussed on disentitling conduct. It was about “what is just and equitable as between the parent company and the subsidiary’s creditors”.

It declined to reduce the quantum of the judgment on the basis that:

Lewis had no responsibility for or culpability in the loss it had sustained, including the failure to seek a parent guarantee, and

the money STH had paid in rent and to remediate the land were for its own benefit.

Take-outs

We repeat our earlier comments. Directors must be careful to ensure that a subsidiary’s interests are kept distinct and that appropriate legal and financial arrangements are made if there is to be a sharing of liabilities between companies within a group.

This includes:

ensuring that the subsidiary’s interests are regarded as distinct from the interests of the parent company or other companies within the group during decision making

running the subsidiary as a separate company rather than as a division of the parent company, with its assets and liabilities treated as its own rather than as the assets and liabilities of the parent company

maintaining appropriate separation of company records and resolutions

ensuring that liabilities are being invoiced to and paid by the appropriate company, and

ensuring the subsidiary company receives independent legal advice to protect its own interests and that formal legal agreements exist for the provision of financial support from the parent company to the subsidiary.

Failure to take these steps will create a risk that a Court will hold the parent company liable for the debts of its wholly owned subsidiary.